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performance data quoted. Investment return and principal value will fluctuate
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July 2018 Portfolio Manager Review

The Markets

In July, global stock markets rebounded as US dollar (USD) appreciation, which caused emerging markets to plunge from May-June, wound down. However, the Korean market underperformed both developed and emerging, failing to join the global upturn. With the US and China bracing for a protracted trade war, Korea’s economic structure that features a heavy export weighting and companies relying much on overseas sales was exposed for its weakness. We believe the Korean market was also weighed down by investor sentiment souring due to the debate about semiconductors peaking and the Kosdaq’s sharp pullback led by pharmaceuticals/biotech stocks.

While the deepening US-China trade spat and China’s slowing economic indicators prompted the Chinese stock market to experience wilder swings, the intensified coupling of asset prices such as currencies and stocks between Korea and China also had an adverse effect on the Korean market. In addition, the KRW/USD (South Korean won to US dollar) witnessed heightened volatility by surpassing (won) W1,135 as the USD turned stronger and the China yuan renminbi (CNY) weaker due to concerns about the trade dispute.

Several major events at home and abroad are in store for August as well. The US is preparing to impose tariffs on USD16 billion (bn) worth of Chinese goods and a public hearing will be held regarding extra tariffs on imports worth USD200bn. Although USD appreciation is easing, the CNY has yet to show a clear uptrend, and this is a risk factor. In terms of supply-demand, the possibility of a passive funds outflow following the second phase of China A-shares inclusion to the MSCI Emerging Markets Index in August is another burden.

However, there are clear signals suggesting that unfavorable factors have peaked. Above all, USD appreciation is easing due to a narrower gap in the economic momentum between the US and other countries and US President Donald Trump’s recent comments. Accordingly, we also focus on better liquidity conditions in emerging countries compared to May and June. Although it is difficult to present an accurate forecast due to the US-China trade war becoming lengthy affair, China still has room for policy momentum such as using fiscal tools and defending the CNY against additional depreciation. As such, unfavorable factors are unlikely to have a significant impact.

While concerns about the trade dispute would persist, the Kospi has limited downside considering the current valuation level. However, earnings momentum remains too weak to fuel a share price upswing. As such, we believe the color of the portfolio is more crucial than the magnitude of the index’s recovery. Given that cyclical sectors took a nosedive in the latest stock market correction, they could rebound just as fast, in our view. In particular, sectors that received a discount to the market such as semiconductors, banks, energy, construction, chemicals and steel have enough room to pick up.

Nonetheless, companies with growth potential are bound to enjoy a share price premium. As sales have limited room to grow due to concerns about slowing economic conditions and the trade war, factors such as higher commodity prices, rising interest rates and the minimum wage increase have an adverse effect on margins. As such, we recommend taking a mid to long-term approach to sectors guaranteed to grow such as IT, healthcare, media/content and Chinese consumer spending-driven stocks.

The Portfolio

In July, the Kospi finished down 1.33% month over month (MoM) due to several negatives such as 1) ongoing trade tensions between the US and China, 2) Korea’s tepid domestic economic indicators and 3) soured sentiment due to the FAANG stocks pullback. The Kosdaq plunged 5.22% MoM due to the financial authorities’ themed inspection of biotech stocks. While all sectors turned downward, utilities and telecom services fared relatively well due to their defensive nature.

Our portfolio widely underperformed the benchmark in July. Although large-cap exports – overweight in our portfolio – reported sound 2Q18 earnings, they performed poorly due to weaker sentiment amid the US-China trade row. Furthermore, major plays in our portfolio retreated due to the FAANG stocks pullback and themed inspection of biotech stocks. Thus, we reviewed the sharply retreated sectors and further scaled up the weighting of pharmaceuticals/biotech and media/content as their pullbacks were excessive.

The Plan

Several events that could dampen the Korean stock market linger ahead in August such as the US and China each imposing further tariffs, uncertainties stemming from a volatile CNY and the potential capital flight of passive funds following the second phase of China A-shares inclusion to the MSCI Emerging Markets Index. However, we also detect signals of passing the trough with a narrowing gap between the economic conditions of the US and other regions, a slower rise for the USD after President Trump’s comments and the easing of US-EU trade tensions.

The economic indicators of major countries indicate that the world’s economy continues to expand despite uncertainties and the second quarter’s (2Q18) earnings at major Korean firms testified to solid profit growth. Taking into account the KRW’s depreciation in 2Q18, domestic companies are even more likely to bolster earnings in the second half of 2018 (2H18). As such, we believe the domestic stock market has entered a phase of excessive undervaluation and further downside risk is very limited.

For the time being, we shall maintain a large portfolio weighting of large-cap exporters as foreign exchange market (FX) effects should bolster their 2H18 earnings. We will assume that the USD’s strength eventually reverts to normal and accordingly build up our portfolio. In the mid to long-term, we shall increase our portfolio exposure to ASEAN’s (Association of Southeast Asian Nations) consumer spending sector stocks, such as consumer goods and media/content, as the strong CNY and stable intra-regional exchange rates hint at potential demand growth.

In 2H18, we plan to aggressively increase the weighting of stocks with healthy fundamentals among those that have been oversold due to the regulatory issues. Stocks in the pharmaceuticals/biotech, SI, advertising and logistics sectors and Kosdaq stocks that have been heavily sold still feature big growth potential and solid profits while accounting audits and the Fair Trade Commission’s investigation are almost over. The government remains committed to boost small and medium enterprises (SMEs) and the Kosdaq market. With sour investor sentiment nearing an end, we believe this is the right time to buy those small/mid-cap stocks from the mid to long-term perspectives.

Before investing you should carefully consider the Fund’s investment objectives, risks, charges and expenses. This and other information is in the prospectus and summary prospectus which can be obtained by visiting www.advisorshares.com. Please read the prospectus and summary prospectus carefully before you invest. Foreside Fund Services, LLC, distributor.

There is no guarantee that the Fund will achieve its investment objective. An investment in the Fund is subject to risk, including the possible loss of principal amount invested. As a result of the Fund’s investments in securities receiving revenues in foreign currencies, the Fund will be subject to currency risk. This is the risk that currencies to which the Fund is exposed will decline relative to the U.S. dollar. Emerging markets can be subject to greater social, economic, regulatory, and political uncertainties and can be extremely volatile. To the extent that the Fund has significant investments in a particular country, the Fund will be susceptible to loss due to adverse market, political, regulatory, and geographic events affecting that country. Economic and political developments of South Korean neighbors may have an adverse effect on the South Korean Economy. Other Fund risks include market risk, equity risk, liquidity risk and trading risk. Please see prospectus for details regarding risk. Shares are bought and sold at market price (closing price) not NAV and are not individually redeemed from the Fund. Market price returns are based on the midpoint of the bid/ask spread at 4:00 pm Eastern Time (when NAV is normally determined), and do not represent the return you would receive if you traded at other times. Holdings and allocations are subject to risks and to change.

The views in this commentary are those of the portfolio manager and may not reflect his views on the date this material is distributed or anytime thereafter. These views are intended to assist shareholders in understanding their investments and do not constitute investment advice.

Definitions:

The KOSPI Index or the Korea Composite Stock Price Index represents all common stocks traded on the Stock Market Division of the Korea Exchange weighted by market capitalization. The KOSDAQ Index measures the performance of Korea's KOSDAQ market, a stock exchange that is weighted by market capitalization. The MSCI Emerging Markets Index is a free float‐adjusted market capitalization index that is designed to measure equity market performance of emerging markets. This index consists of the following 24 emerging market country indexes: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Pakistan, Peru, Philippines, Poland, Qatar, Russia, South Africa, Taiwan, Thailand, Turkey and United Arab Emirates.